Innovation and Firm's International Expansion: A Dynamic Approach

Maria Luisa Petit and Francesca Sanna Randaccio - University of Rome "La Sapienza" and Boleslaw Tolwinski - ORE

The literature that analyses the effects of technological innovation on production and welfare considers firms producing within a single economy and therefore ignores any problems related to firms foreign expansion. On the other hand, the literature on firms' foreign expansion focuses on the trade-direct investment choice and does not take into account the effects of technological innovation. This paper is an attempt to integrate these two different branches of the literature. We consider an international setting where firms take decisions on both research expenditures (R&D investment) and the level of output, and also take into account the possible choices for foreign expansion. The paper examines the influence of R&D decisions on the resulting market structure, and vice versa. The effects on consumer welfare of the different choices made by the firms are also analysed. We consider a two country model where firms producing in each country have the possibility to serve the other country either by creating there a new plant or by exporting. We assume process innovations, and refer to both the cases of symmetric and asymmetric firms, where the differences may be due to different past technological accumulation paths or to different rates of innovation. The models considered are dynamic and describe both cooperative and non-cooperative dynamic (Markov) games between the two international firms. The equilibrium market structure is determined in a three step procedure. In the first step the firms decide on the number of plants. In the second step each firm decides how much to invest in R&D, and, in the third step, the ammount of sales in both countries. The resulting three step game is solved backwards and feedback Nash equilibria are obtained. Since the models considered are non-linear, the computation of dynamic equilibrium strategies require the use of numerical techniques. A numerical algorithm has been used based on a modified policy iteration method that is capable of computing feedback Nash equilibria for some non-linear dynamic games outside the standard linear-quadratic formulation.

Scheduled for Session 4.3 Innovation And Pricing